Earnings Call Transcript - EGAN Q1 2020

Operator, Operator

Good day. And welcome to eGain's Fiscal 2020 First Quarter Financial Results Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Jim Byers of MKR Investor Relations. Please go ahead, sir.

Jim Byers, Investor Relations

Thank you, operator, and good afternoon, everyone. Welcome to eGain's First Quarter Fiscal 2020 Financial Results Conference call. On the call today are eGain's Chief Executive Officer, Ashu Roy; and Chief Financial Officer, Eric Smit. Before we begin, I would like to remind everyone that during this conference call, management will make certain forward-looking statements, which convey management's expectations, beliefs, plans and objectives regarding future financial and operational performance. Forward-looking statements are generally preceded by words such as believe, plan, intend, expect, anticipate or similar expressions. Forward-looking statements are protected by safe harbor provisions contained in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to a wide range of risks and uncertainties that could cause actual results to differ in material respects. Information on various factors that could affect eGain's results are detailed on the company's reports filed with the Securities and Exchange Commission. eGain is making these statements as of today, November 6, 2019, and assumes no obligation to publicly update or revise any forward-looking information in this conference call. In addition to GAAP results, we will discuss certain non-GAAP financial measures such as non-GAAP operating income. Our earnings press release can be found on the news release link on the Investor Relations page at eGain's website. The tables included with the earnings press release include reconciliation of the historical non-GAAP financial measures to the most recently comparable GAAP financial measures. And lastly, a replay of this conference call will also be available at the Investor Relations section of eGain's website. And now with that said, I'd like to turn the call over to eGain's CEO, Ashu Roy.

Ashu Roy, CEO

Thank you, Jim, and good afternoon, everyone. We achieved a solid performance across the board in Q1. This included top and bottom line results that exceeded our guidance, and we're ahead of Street consensus. We also generated good cash flow from operations in the quarter. Let me share some financial highlights. Our SaaS revenue grew 30% year-over-year. Our subscription revenue grew 13% year-over-year and comprised about 91% of our total Q1 revenue. We were GAAP profitable for the quarter with net income of $1.2 million compared to net income of $600,000 in the same quarter of last year. Finally, we generated $2.7 million in cash from operations in the quarter. So all in all, very strong numbers and a good start to the year. Looking at the business, the last quarterly earnings call we did was just a few weeks ago. What I can tell you, which is all good, is that we have nice bookings in the quarter with a healthy mix of new customers and expansion opportunities. One of the things I want to talk about in terms of market and customer feedback is the Experience 360 event that we had in Chicago, which is our customer event in North America. We had this event on October 15 and 16, and it was very successful. Some of you attended that event as well. I would say there are three things I want to bring out from that event that speak to the state of our business and where we're going. First is around customers, second is around partners and the third is around products. At this event, three of our clients presented their journey with eGain. It was fantastic to hear their perspectives. They were different, but there were commonalities as well. The three of them were Comcast, who needs little introduction; Lands' End, many of you know, an iconic apparel brand; and Northern Trust, a global wealth and asset management leader. Comcast, when they presented, highlighted the speed and scale at which they have consumed innovation on the eGain platform. Over the last couple of years, they have shifted their customer care volume from voice to digital, primarily for their Xfinity business, which includes a lot of products. In that business, they see a 15 to 20 point Net Promoter Score advantage when they compare their digital customer service to their voice-based customer service. As Eric Burton, the VP of Comcast who presented, put it, if that 15 point NPS advantage is not worth getting out ahead for, I don't know what is. We completely agreed, and that customer experience advantage is phenomenal, and big companies like Comcast are recognizing that they can achieve tremendous improvement in customer experience and satisfaction just by delivering customer care digitally rather than through voice, which also offers significant cost advantages—around a twofold improvement in a typical scenario based on messaging and chat over voice. Then Lands' End discussed how they are expanding their digital customer service and adding virtual assistance and messaging all on the eGain platform. This is in addition to the current capabilities they have around knowledge, guidance, chat and email-based service from eGain. They also shared their strategy of delivering convenience and choice in an omnichannel world. Lastly, Northern Trust shared their story of a global deployment of eGain for digital customer care and the results they achieved in terms of better service levels, productivity and customer satisfaction. They also outlined their intent to further expand their omnichannel service options on the eGain platform. We were very grateful to our clients for sharing those great customer successes and stories. A common theme across these clients was their strategic commitment to a modern, digital-first customer engagement, and their focus on consuming innovation at speed and scale, with eGain being the partner of choice in these cases. Our solution stands apart from the market in terms of its connected richness and ease of implementation, which our clients experience, and our prospects learn about during our risk-free trial of innovation in 30 days. Turning to partners, at the event, all three of our contact center technology partners, Cisco, Avaya and Amazon, participated, which is great. It was heartening to see positive and enthusiastic attendee interest in their joint proposition and our solution with them. With increased sales investment in channel-led growth, we are starting to see nice pipeline growth. We expect this trend to continue through the rest of the year. Lastly, as mentioned in our press release, we launched some exciting new capabilities on our cloud platform as part of our Fall 2019 release. I'll run through the important ones. The first one was eGain Messaging Hub, which enables businesses to rapidly engage with their customers across all messaging channels, including Apple Business Chat, SMS, WhatsApp, Facebook and others. Using the Hub, businesses can effortlessly launch new ways of connecting with their customers, either proactively or through interactive messaging, which is chat-based. All these interactions leverage our eGain AI technology. There are other companies in the marketplace that offer similar messaging hubs, but most of them are point solutions, forcing businesses to glue them together with their knowledge and AI assets. Our solution, however, comes with the capability of having all these dots pre-connected, available in one place—simple and powerful. The next capability we announced, which was very exciting, was the Virtual Assistant for Agents. We have been marketing virtual assistants for self-service for customers, but this more directly applies to the agents, enabling the virtual assistant to monitor digital conversations on the agent's desktop and serve up best-practice guidance and knowledge when relevant. Our clients love the idea of relevant, prompted guidance so that their agents can focus on working with customers. Next, we announced a new way of applying our technology for sales, which we call the eGain Sales Advisor. Recall that we brought Evan Siegel, a banking industry veteran, on board earlier this year. His mandate was to pursue new growth initiatives, particularly in our top vertical, which is financial services. In six months, he successfully led a small team internally to conceive and build the eGain Sales Advisor, which helps guide and coach sales agents in an easy, best-practice-driven manner while ensuring compliance in the sales process. In short, it makes all your sales agents as good as your best sales agent with process guidance. The interest in this solution from the conference attendees was phenomenal, and now Evan's team has secured a pilot project, so we're off to the races and the pipeline is building. It's very exciting to see us extending our core technology and capability to serve the sales side of our business clients, not just service, which is our current focus. Moving to the optimized layer of our platform, we announced two capabilities. One was analytics for Amazon Connect, which is a rich solution for omnichannel analytics on the voice side of Amazon. We also introduced our new IVR Analytics capability, which leverages our core technology in analytics to address a significant unmet need in the market around IVR interactions. Approximately three out of every four calls into a business for customer care end up in IVR, whether getting results or abandoned. Most businesses have no idea what occurs in those 75% of voice calls. Companies want to know who called, why they called, their experience in IVR, and what happens when they escalate. Our IVR Analytics solution enables businesses to understand that behavior and assess the customer experience. We don't know of any other product in the market that has this level of integration. All these innovative capabilities come with leading-edge features, all connected and available on our common platform, with the ease and richness that are unique to eGain. Looking forward, we are ramping our sales investments systematically. We are now allocating close to about 30% of our top line into sales and marketing for Q1. We will slightly shade under that, but all of it will be leveraged through channels. We continue to systematically hire and onboard people for the three layers of investment we are making: marketing first, followed by channel, and finally, sales heads to respond to the generated demand. We are quite enthusiastic about accelerating our SaaS growth this year. With that, I'll ask Eric Smit, our Chief Financial Officer, to add more color around our financial operations.

Eric Smit, CFO

Great. Thanks, Ashu. As Ashu noted, we achieved top and bottom line results that exceeded our guidance and were ahead of Street consensus. We generated strong cash flow from operations in the quarter. Looking at the financial highlights for Q1, SaaS revenue was up 30% year-over-year, and 33% in constant currency. Our non-GAAP gross margins were 70% for the quarter, an improvement both sequentially and year-over-year. Non-GAAP net income was $1.7 million or $0.06 per share on a basic and $0.05 per share on a diluted basis, up from non-GAAP net income of $1.2 million or $0.04 per share a year ago. We generated $2.7 million in cash from operations during the quarter, resulting in a cash flow margin of 16%. Now looking at our quarterly results in more detail, total revenue in Q1 was $17.2 million, up 9% year-over-year, or 12% in constant currency. Subscription revenue was $15.6 million or 13% year-over-year, 16% in constant currency, and accounted for 91% of total revenue, which is up from 87% a year ago. SaaS revenue was $12.4 million or 30% year-over-year, accounting for 72% of our total revenue in Q1. Our trailing 12-month SaaS retention rates remained healthy, with gross retention in the mid to low 90% range and net retention, including upsell and uplift, north of 100%, consistent with last quarter. Legacy revenue was $3.2 million, down 24% from the year-ago quarter, now accounting for 18% of total revenue in Q1, down from 26% a year ago. As we've noted on past calls, we are driving an accelerated transition of our on-premise customers to our cloud offering. As such, we expect to see a faster decline in legacy revenue over the next several quarters. We're targeting legacy revenue to decrease to less than 10% of total revenue by the end of calendar 2020. This accelerated transition has led our legacy retention rates to come down slightly into the mid-80s range. Professional services revenue was $1.6 million or 10% of total revenue, down 18% from $2 million, or 13% of total revenue in the year-ago quarter. Our goal was to get our PS revenue into the low double-digit or high single-digit range as a percentage of total revenue, and now that we've achieved this goal, we expect our PS revenue to remain in this range going forward. Now looking at our non-GAAP gross profits and gross margins, gross profit for the first quarter was $12 million or a gross margin of 70%, up from a gross profit of $10.6 million or a gross margin of 68% a year ago. The year-over-year increase in overall gross margin reflects a combination of benefits we are seeing in terms of scale and efficiencies around cloud operations and the growth in our high-margin SaaS revenue while our lower-margin PS revenue declines. Now turning to operations, non-GAAP operating costs for the first quarter came in at $10.4 million compared to $9.3 million in the year-ago quarter, driven by increased investments in sales and marketing and product development. This resulted in non-GAAP operating income in the first quarter of $1.6 million, with an operating margin of 9%, compared to $1.4 million or a margin of 9% in the year-ago quarter. Looking at net income, non-GAAP net income for the first quarter was $1.7 million or $0.06 per share on a basic and $0.05 per share on a diluted basis. This compares to non-GAAP net income of $1.2 million or $0.04 per share on a basic and diluted basis in the year-ago quarter. GAAP net income for the first quarter was $1.2 million or $0.04 per share, compared to GAAP net income of $604,000 or $0.02 per share in the year-ago quarter. Turning to our balance sheet and cash flows, total cash and cash equivalents as of September 30, 2019, was $34.4 million compared to $31.9 million at June 30, 2019. During the quarter, we generated cash flow from operations of $2.7 million compared to $3.3 million in Q1 last year. Now turning to our guidance, for the fiscal 2020 full year ending June 30, 2020, we are reiterating our previously provided guidance for SaaS revenue of $53.8 million to $55.4 million on a constant currency basis, which represents growth between 20% and 24% year-over-year, and total revenue of $72 million to $73.6 million on a constant basis, representing growth between 7% and 10% year-over-year. We expect to generate non-GAAP net income of between breakeven to $2 million or $0.00 to $0.06 per diluted share, and we assume a diluted share count of 32.6 million for the fiscal year. Looking at the foreign exchange impact of the pound to the dollar on our first quarter results, you can see the impact accounted for approximately $300,000 difference in our SaaS revenue and about a $400,000 difference in total revenue for Q1. Given the strength of the pound to the US dollar so far this quarter, we do not anticipate a significant FX impact on our results for the remainder of the year. Now looking ahead to the fiscal 2020 second quarter, we expect SaaS revenue of between $13.3 million to $13.7 million and total revenue of $17.2 million to $17.7 million. We expect to generate non-GAAP net income of $200,000 to $700,000 or $0.01 to $0.02 per diluted share, and we have assumed a diluted share count of 32 million for the second fiscal quarter. Adding further color to our Q2 guidance, we expect to see less of a seasonal impact benefiting our SaaS revenue this Q2 than we saw last year. This is a function of an increase in our base-level business and the way certain of our agreements have evolved, which is expected to reduce overages that boosted our Q2 results last year. Instead of a significant spike in Q2 followed by a decline in our third and fourth quarters, we expect to see a more linear improvement in our SaaS revenue throughout the year, which we view as a positive change. Lastly, on the Investor Relations front, eGain will be participating in two upcoming investor conferences next week. We will be participating in the Craig-Hallum Annual Alpha Select Conference taking place November 12 in New York, and the following day, we will be participating in the ROTH Technology and Cleantech Conference on November 13, also in New York. We hope to see some of you there. This concludes our prepared remarks. Operator, we will now open the call for questions.

Operator, Operator

We'll go first to Ryan MacDonald with Needham.

Ryan MacDonald, Analyst

Good evening Ashu and Eric. Thanks for taking my questions. Congrats on the strong first quarter numbers. I guess, first off, in terms of the guidance you provided, Eric, I know you made some comments about maybe some impacts throughout the year, some changes here. But I guess the guidance right now, at the high end, assumes sort of a flat year-over-year growth to maybe slightly down. Can you talk about maybe what some of the moving parts of that guidance are? And I think it also assumes in the SaaS growth guidance, a bit of a deceleration into maybe the mid-teens there. So we'd love to hear some more color on that, if possible. Thanks.

Eric Smit, CFO

Just to confirm, Ryan, are you referring to the Q2 numbers? Is that...?

Ryan MacDonald, Analyst

Yes, the Q2 numbers.

Eric Smit, CFO

Yes. If you recall, last year, we mentioned on the call approximately a $900,000 benefit from seasonal one-time revenue that, as I noted in my prepared remarks, as certain of these contracts have evolved, we are instead looking to see more sequential improvements in the growth of the SaaS revenue as opposed to, as I've mentioned, last year we had a huge spike and subsequent decreases in revenue. So we are maintaining our guidance for the year. Instead of it being front-end loaded into Q2, we expect to see that growth rate continue throughout the year, if that makes sense.

Ryan MacDonald, Analyst

And then in terms of the planned investments, can you talk about how you're tracking to internal plans on that increased level of investment on sales and marketing and R&D, and then how we should expect the cadence of the additional investment to play out through the remainder of the year?

Ashu Roy, CEO

This is Ashu here, Ryan. We talked about increasing our sales and marketing investments to a certain level, and I think we are right around that level for Q1. I think we'll continue to see the increases indicated. Leading up, I think we will probably exit Q4 around the 35% level, that's my sense, of sales and marketing investments as a percentage of revenue. Now that's not going to jump up to 35% instantly, but that's the trajectory that we are on.

Eric Smit, CFO

One more point to add, Ryan. There is an element of seasonality in the sales and marketing spend. For Q2, where we have the customer event that Ashu talked about, we certainly expect to see more increases sequentially from the Q1 numbers as a result.

Ashu Roy, CEO

Good point. And that applies to Q4 as well because we do a significant event in London. So Q2 and Q4, you'll see those spikes in the marketing plan.

Ryan MacDonald, Analyst

Thank you. And then I guess just one more for me. In terms of the migration or accelerated migration of customers to get them over to the cloud, I know you mentioned you want to have that completed by the end of calendar year '20. How should we think about the pace of those migrations throughout the remainder of the fiscal year?

Eric Smit, CFO

So, as we've said in the past, there’s a step function in it for some of the larger remaining legacy customers. We would see some fairly steep declines in revenue when we move them, so it's not always easy to predict the timing of these activities. But as opposed to it being gradual, we expect to see some significant changes within a few quarters.

Ryan MacDonald, Analyst

Got it, thank you very much.

Eric Smit, CFO

We might see anywhere from several hundred thousand dollars decline as meaningful customers move.

Operator, Operator

We go next to Richard Baldry with ROTH Capital.

Richard Baldry, Analyst

Sort of curious that recurring cost line fell sequentially pretty meaningfully sort of more in line with what you had mid last year. Is there anything unusual in that? Or do you see any step function growth ahead? Should we look at this as a new baseline?

Eric Smit, CFO

A couple of factors. One, just to reiterate the point about sales and marketing spend generally being lighter in Q1. We expect to see that pick up again in Q2. Additionally, certain year-end expenses around our Q4 numbers caused those costs to be higher, so some of those elements recorded in Q4 impacted the numbers. To clarify, we do not anticipate a dramatic change in margin profile.

Richard Baldry, Analyst

Yes, more focused on the recurring line.

Eric Smit, CFO

We'll obviously continue to see that increase as revenue grows, but we don't anticipate a dramatic change in the margin profile.

Ashu Roy, CEO

I'll add a little bit of color to that. The recurring line is somewhat sensitive at this scale because we use partners for infrastructure as a service to public cloud with Amazon and Azure. We keep working with them to drive better value for us. There can be a catch-up element in terms of recurring costs, and we believe Q4 had some of that.

Richard Baldry, Analyst

If I look back over the past two years, the pattern of deferred revenues has been growing significantly over the past several quarters on a sequential basis. How should I evaluate the deferred revenue growth seasonally? Or is it more likely to become a sequential grower due to the exit from the legacy line?

Eric Smit, CFO

We're always a little cautious about reading too much into the deferred revenue line due to the timing of renewals. When you replace multiyear renewals with single-year ones, it complicates interpretation. At this point, I'm not sure if we can provide more insight into it.

Richard Baldry, Analyst

Your balance sheet has been improved for a couple of quarters now. Has this had any impact on your pipeline, your ability to engage with larger customers, attract higher-end employees, or influence your win rates in competitive deals? What are your thoughts?

Ashu Roy, CEO

It's a good question. It's hard to correlate improved win rates right now. Customers have noted our solid balance sheet, which is encouraging. However, quantifying the impact has been challenging. That said, there's a clear positive change in our company confidence and our ability to execute growth initiatives. We know we can sustain our investments in sales and marketing throughout this growth phase.

Eric Smit, CFO

Prior to the balance sheet improvements, I received frequent requests from salespeople participating in due diligence calls around our financial viability. Since the financing, I have not received any such calls.

Richard Baldry, Analyst

If we look at the growth in the SaaS revenue sequentially from the June quarter to September, it's almost two to three times the dollar sequential growth you saw in the prior period. Can you discuss if this suggests a material step-up in sales productivity? Or might it be a go-live timing issue we shouldn't view as an outlier in execution given its dramatic year-over-year improvement? Thanks.

Ashu Roy, CEO

Largely, we should attribute this to the timing of deals getting done earlier in the quarter. Sometimes large deals slip from prior quarters, which can have a significant impact. This is likely the most considerable factor. Bookings have been good, but I wouldn't attribute this to a single significant driver.

Operator, Operator

We'll go next to Jeff Van Rhee with Craig-Hallum Capital Group.

Rudy Kessinger, Analyst

This is Rudy on for Jeff. A couple of questions from me. One, I believe you said last quarter that new bookings in Q4 were about a little over 60% from existing customers, a little under 40% from new. I'm curious how that was in this quarter. In terms of the pipeline, over the past three to six months, what products have been driving the pipeline? I know you talked about the Sales Advisor driving good pipeline so far, but if you could touch on the products driving the pipeline?

Ashu Roy, CEO

Sorry, Jeff. I got the first question. Can you repeat the second question, please?

Rudy Kessinger, Analyst

Secondly, on the pipeline, which products, if you had to rank them, are driving growth?

Ashu Roy, CEO

Regarding existing versus new, the percentage for Q1 is materially similar, likely in the low 60s for existing expansions, with the remainder being new customers. The products driving growth mostly come from knowledge and AI initiatives on the new side, while messaging and digital capabilities also see significant entry points. These two are the top drivers we have observed for new logos.

Rudy Kessinger, Analyst

And regarding investments in sales and marketing, what do you expect in terms of additional direct capacity for sales in the next 12 months? What are your thoughts?

Ashu Roy, CEO

On the sales side, we're likely going to be adding about 30% capacity. However, the incremental investment in channels and marketing will be higher in percentage terms, as we believe that's a more significant leverage for us.

Operator, Operator

And at this time, I show no further questions.

Ashu Roy, CEO

Okay, thanks everybody. I appreciate you listening, and hopefully we'll have the chance to meet some of you in New York next week. Thank you.

Operator, Operator

Ladies and gentlemen, this does conclude today’s conference. We thank you for your participation. We may now disconnect.